Tax relief stalemate hangs over RMBS mortgage bonds

NEW YORK, Sept 4 (IFR) - Investors holding non-agency RMBS bonds could wind up with surprise losses if US mortgage debt relief legislation is not extended soon, but the measure has been held up by political stalemate.

Homeowners could face steep tax bills if the 2007 Mortgage Debt Relief Act is not renewed before April 2015, which could cause some to walk away from their loans - in turn putting pressure on legacy RMBS.

The measure, which has been extended once already, exempts up to US$2m of mortgage debt forgiven by a lender from being considered as US federal taxable income.

But with mid-term elections looming in November, a new extension has been held up on Capitol Hill, and some market participants are beginning to get nervous.

The Senate put together a procedural vote to pass the bill in May, but final terms have still not been agreed amid partisan wrangling over prolonging the tax relief.

“No candidate on either side wants to do anything to give their opponent any additional ammunition,” one housing lobbyist told IFR.

If homeowners who accept principal forgiveness from mortgage servicers have to pay tax on that amount, that could well change the equation for the collateral under RMBS bonds.

The most recent data from CoreLogic showed that 12.7% of US homes with mortgages - or roughly 6.3 million - are still worth less than the outstanding debt.

Some owners of those homes would likely walk away from their properties altogether if they face an additional tax burden, which would result in more delinquencies - a negative for bondholders exposed to those loans.

KEY FACTOR

According to data from JP Morgan and MBS Data, a mortgage analytics firm, more than 43% of all legacy non-agency RMBS bonds that have been modified involve some principal reduction.

Option ARMs in particular have higher rates of principal modifications, with 58.9% of their modifications involving a principal reduction - much higher than the 19.6% level in prime bonds.

While many in the market expect that Congress will extend the bill eventually - and that it will be applied retroactively - the lack of clarity is creating a headache for some.

“This puts a number of the mortgage servicers in a tough bind,” said one RMBS analyst.

“They may extend principal forgiveness to a borrower but would be unable to provide any guidance on whether the modification will be taxable or not.”

The lobbyist said the best chance for all tax extenders to pass would be during the “lame duck session” following the mid-term elections in November.

Bank of America for its part has already set aside US$490m to cover any potential taxes borrowers would have to pay if the bill is not extended.

The move was part of the bank’s US$16.65bn settlement with the US Department of Justice on August 21.

“Until Congress acts, the hundreds of thousands of consumers we have sought to help through our settlements with JP Morgan Chase, Citigroup, and now Bank of America may see a significant tax bill just as they are beginning to see the light at the end of a dark financial tunnel,” Attorney General Eric Holder said at the time. (Reporting by Andrew Park; Editing by Shankar Ramakrishnan, Natalie Harrison and Marc Carnegie)